Sinoma Energy Conservation Ltd. (SHSE:603126) shares have continued their recent momentum with a 28% gain in the last month alone. Looking further back, the 20% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Since its price has surged higher, Sinoma Energy Conservation's price-to-earnings (or "P/E") ratio of 66.2x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 36x and even P/E's below 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at Sinoma Energy Conservation over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Sinoma Energy Conservation's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. The last three years don't look nice either as the company has shrunk EPS by 62% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Sinoma Energy Conservation's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Sinoma Energy Conservation's P/E?

The strong share price surge has got Sinoma Energy Conservation's P/E rushing to great heights as well. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Sinoma Energy Conservation currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Sinoma Energy Conservation is showing 3 warning signs in our investment analysis, and 1 of those is significant.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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